Equities of almost all descriptions had a stellar 2013, defying the widespread skepticism that marked the beginning of the year. Â Predictably, investors’ enthusiasm grew as stocks climbed. Â Although we do not expect returns in 2014 to match those in 2013, we remain cautiously optimistic. Â Â
Last year, we began providing a five-year performance overview as the centerpiece of our December commentary. Â The picture today is very different from that of a year ago, even though four of the calendar years in our snapshot remain the same. Â Replacing the awful equity losses from 2008 with the fantastic stock gains from 2013 alters the landscape substantially, on paper and in investors’ minds.
At Ariel we track domestic stocks across the cap ranges, international issues, and even bonds. The returns below represent five calendar years, along with an annualized return for the entire period.Â
In 2013, domestic stocks ruled the roost with phenomenal gains, followed by substantial international equity gains, with bonds’ losses bringing up the rear. Â U.S. equities of most descriptions fared very well in inverse size order: Â Small-caps topped mid-caps, which outperformed large-caps. Â The one key difference: Â Bonds had a recently rare negative return. Â Â
Sentiment has shifted dramatically from a year ago for many investors. Â Last year at this time we wrote:Â
From our perspective, the story of the last half-decade continues to be investors’ love affair with bonds and extreme distrust of equities—despite the handsome returns stocks have generated of late. Â Although December results are not yet available, it is clear that 2012 will be the fifth straight year of outflows from U.S. stock funds—totaling approximately $300 billion in total over the full period. Â Meanwhile, investors have plowed more than triple that amount—over $1 trillion—into municipal and taxable bond funds.Â
Our view a year ago was that investors’ anxiety regarding equities was misplaced:  Not only did returns support this view in the short-term, but investors reversed course over the course of the year.  Indeed, investors rediscovered equities and largely turned their back on bonds.  In 2013 (before December flows, which are not yet final), international stock funds had inflows of $135 billion, and domestic stock funds gained $77 billion in new assets.  Meanwhile, taxable and municipal bond funds experienced $20 billion in outflows.  We think the main reason is that after the aberrant period of late 2007 through early 2009 finally receded into history, the long-term performance trend is back in place.  That is, bonds’ annualized returns are in the mid-single-digits, with equities delivering double-digit annual gains.  For investors, stocks are no longer remembered as the asset class that fell so far in the crisis; they have become again the investments with the best long-term returns.Â
With that in mind, while we have become more cautious than we were, given the dramatic gains and change in sentiment, we remain optimistic. Â On the one hand, the rush into equities and especially their apparently lofty return expectations give us pause. Â On the other hand, global growth remains subdued, and few seem to anticipate an acceleration. Â Ultimately, however, we think independently and neither embrace nor automatically refute the crowd’s view. Â We hold that slow economic growth is unlikely to remain in place forever, and think an uptick is likely to justify higher equity valuations. Â Most importantly for our clients, in all of our strategies—from the deep value small- and micro-cap arena, through our small- to mid-cap traditional portfolios, to our all-cap holdings at home and abroad—our managers continue to find enough opportunities to keep the portfolios full and, in our view, attractive on a risk/reward basis. Â Â
The opinions expressed are current as of the date of this commentary but are subject to change. The information provided in this commentary does not provide information reasonably sufficient upon which to base an investment decision and should not be considered a recommendation to purchase or sell any particular security. Past performance is no guarantee of future results. Â
Bonds are fixed income securities in that at the time of the purchase of a bond, the amount of income and the timing of the payments are known. Â Risks of bonds include credit risk and interest rate risk, both of which may affect a bond’s investment value by resulting in lower bond prices or an eventual decrease in income. Â Treasury bonds are issued by the government of the United States. Â Payment of principal and interest is guaranteed by the full faith and credit of the U.S. government, and interest earned is exempt from state and local taxes. Â
The Russell 2000® Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000® Index representing approximately 8% of the total market capitalization of that index. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership. Â The Russell Midcap® Index measures the performance of the mid-cap segment of the U.S. equity universe. The Russell Midcap Index is a subset of the Russell 1000® Index. It includes approximately 800 of the smallest securities based on a combination of their market cap and current index membership. The Russell Midcap Index represents approximately 27% of the total market capitalization of the Russell 1000 companies. Â The S&P 500® Index is the most widely accepted barometer of the market. It includes 500 blue chip, large cap stocks, which together represent about 75% of the total U.S. equities market. Â MSCI EAFE® Index is an unmanaged, market weighted index of companies in developed markets, excluding the U.S. and Canada. Source: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used to create indices or financial products. This report is not approved or produced by MSCI. Â The U.S. Aggregate Bond Index is a broad-based benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market, including Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM passthroughs), ABS, and CMBS. The U.S. Aggregate rolls up into other Barclays flagship indices, such as the multi-currency Global Aggregate Index and the U.S. Universal Index, which includes high yield and emerging markets debt.
